Example Assignment_Dulux (1)
Dulux Group
Managing foreign exchange risk
and equity investment
Commented [A1]: Overall, there are some grammatical e
ors,
and lack of theoretical supports as well as explanations on the
arguments.
Method and equations can be presented to help readers to
understand where the computed numbers came from.
In addition, some improvements can be made in the presentation of
the report (e.g. using a consistent number of decimal points in the
table and etc.,)
1. Introduction
A recent cu
ency war among governments; aiming to gain a trade advantage over
other countries by devaluating ts own cu
ency, has increased the volatility of the
cu
ency market. Under this uncertain cu
ency market environment, both multinational
and purely domestic companies are facing a difficult balancing act. The behaviour of
foreign exchange rates not only directly affects the balance sheet or income statement but
also indirectly alters competitiveness of companies.
We understand that Dulux Group, by manufacturing and selling housing
interio
exterior as well as construction products to various countries including Australia,
New Zealand, Papua New Guinea, China and South-East Asian countries, is exposed to
isks associated with foreign cu
ency fluctuations. Although the company has been
actively engaging with reducing cu
ency risks by diversifying its employment and by
entering financial contracts, a further measure can be employed to mitigate such a type of
isk while reducing the implementation costs.
Obtaining clearer understanding about the future cu
ency movement allows the
company to take a better position in negotiating with counter parties including financial
institutions who provide financial hedging products. As a preliminary report, we select
three cu
encies that we believe the company is exposed against and conduct basic
analyses on how would those cu
encies behave in a foreseeable future and on which
hedging policy would best suit the company. Furthermore, we acknowledge that the
company is seeking opportunities of equity investment.
In summary, we have identified three foreign cu
encies, namely, USD, PGK, and
CNY that the company is potentially exposed against. Those cu
encies are selected based
on the information provided by the annual report of the company; however, our analyses
indicate potential divergence between the perception of the shareholders and the
information provided by the company in relation to the cu
encies that may impact the
company’s business performance. In addition, based on the assumption that the selected
cu
encies in fact affect the business environment of the company, our study demonstrates
that the money market hedging is the ideal hedging method for Dulux Group.
Commented [A2]: This paragraph does not provide clear picture
about whether the company’s overseas segments simply are for
production or are gaining a large amount of revenues.
2. Cu
ency risk
In this section, we identify foreign cu
encies that potentially affect the earnings of
Dulux Group. At this moment, we do not have access to the
eakdown of company’s
eginal balance sheet as we have not yet signed a formal confidential agreement. For this
eason, our analyses use the equity value of the company represented by the exchange
traded stock price.
For the cu
encies used for the analyses we have selected the U.S., dollar (USD),
Papua New Guinean Kina (PGK) and Chinese Yuan Renminbi (RMB). Those cu
encies
are selected by examining the company’s annual report. As illustrated in Figure 1, these
cu
encies have the largest impact on its equity and annual profit. The selection of the
cu
encies is largely consistent with the production sites shown in Figure 2 and its
customer locations. According to Figure 3, New Zealand appears to be the second largest
origin of its revenues and the non-cu
ent assets, after Australia. Nevertheless, the
exchange rate risk associated with New Zealand dollar seems smaller than the
aforementioned cu
encies. This can be due to the successful hedging strategies enforced
y the company.
Based on the information provided in Figure 1, as the appreciation of USD and
RMB against AUD have an adverse effect on its net profit, we expect that there is a
negative relationship between the stock price of the company and the exchange rates of
AUD against those cu
encies (when they are denominated in per AUD). On the other
hand, PGK and the stock price would have a positive relationship. However, we have to
note that the impact of changes in those cu
encies appeared in Figure 1 merely reflects
its translation exposure, in other words not the transaction exposure which influences
company’s cash position.
Commented [A3]: The title is not so informative
Commented [A4]: In most cases in the report, CNY is used to
epresent yuan. Be consistent.
Commented [A5]: Why?
Figure 1: Dulux net exposure to foreign cu
ency movement
Source: Dulux Group
Commented [A6]: For which year?
Commented [A7]: The table is a bit busy and hard to extract
elevant information. May be better to summarise the information
and prepare your own table.
Figure 2: Dulux production sites
Source: Dulux Group
Figure 3: Dulux proportion of revenues by countries and regions
Source: Dulux Group
Next, we examine the relationship between the stock price of the company and those
three cu
encies. In order to conduct the analyses, we have obtained stock price and the
cu
ency exchange rates against AUD (in the notation of per AUD) from January 2010 to
January 2017 in a monthly basis. The data are in the monthly return format. Figure 4
examines the relationship between the stock return and the return of each cu
ency return.
It appears that in some instances, the stock price and the exchange rate are moving in the
same direction (e.g., in 2010 and XXXXXXXXXXHowever, it was somewhat expected from the
progressive phenomenon of global integration, the three cu
encies are taking similar
paths. To take this into account, we believe that we have to conduct a statistical analysis
which allows us to control such an issue. One way to overcome this is to run a multiple
egression.
The regression results are presented in Table 1. In the regression model, the stock
price return is used as a dependent variable and the three cu
encies are used as
independent variables. The analysis obtained a relatively low coefficient of determination
value. This is reasonable as there are various other factors affecting the value of the
company. Thus, our main focus is the betas obtained in the analysis. While the
coefficients for the cu
ency variables are statistically insignificant at 10 per cent level
Commented [A8]: For which year?
Commented [A9]: Need to support your argument
Commented [A10]: What is the actual value? And this suggests?
(this may be a reflection of the cu
ency exposure observed in Figure 1 is the translation
exposure), we can still provide economic implications of the coefficient values. In
particular, 1 per cent increase in the AUD against USD and PGK pushes the stock price
y 0.3% and 0.7%, respectively. By contrast, 1 per cent appreciation of AUD against
RMB causes 0.7% decline in the stock price. Interestingly, for the PGK and RMB
variables, the sign of the coefficients obtain in the regression analysis are inconsistent
with the expectations drawn from Figure 1. This implies that there may be some economic
type of cu
ency exposures with those countries. In the next section, we make 1-year
forecasts for the relevant cu
encies.
Commented [A11]: Why?
Commented [A12]: In some cases, “per cent” is used. Need to
use a consistent term.
Commented [A13]: What was your expectation?
Figure 4: Dulux stock price and foreign exchange rate returns (monthly basis)
Source: Yahoo Finance, the Reserve Bank of Australia
Table 1: Multiple regression result (monthly basis)
Regression Statistics
Multiple R XXXXXXXXXX285
R Square XXXXXXXXXX081
Adjusted R Square XXXXXXXXXX044
Standard E
or XXXXXXXXXX048
Observations 78
Beta Std. E
t Stat P-value
Intercept XXXXXXXXXX0.03)
USD XXXXXXXXXX0.65)
CNY XXXXXXXXXX (0.35)
PGK XXXXXXXXXX0.11)
Source: Yahoo Finance, the Reserve Bank of Australia
Note: This table presents the regression analysis result. The dependent variable is the stock price monthly return of
Dulux and the dependent variables are monthly return of USD/AUD, CNY/AUD and PGK/AUD.
2. Cu
ency forecast
This section provides the forecasts of three selected cu
encies using two different
approaches, the International Fisher Effect (IFE) and the Purchase Power Parity (PPP).
Required data for making the forecasts are shown in Table 2. The forecasts are presented
in Table 3. According to the IFE, AUD would worth 0.76 USD, 2.582 PGK and 5.323
CNY in 1 year. By contrast, based on the PPP, AUD would worth 0.77 USD, XXXXXXXXXXPGK
and 5.272 CNY. While there is no liquid forward market for PGK, the value of AUD in
1 year is quoted as XXXXXXXXXXUSD and XXXXXXXXXXCNY under forward contracts. As there are
deviations between the forward rates and our forecasts, there may be exploitable a
itrage
opportunities. However, the deviations generally are small and therefore, after
considering transaction costs such an opportunity is believed to disappear.
If we assume that the forward rate is a good predictor of a future spot rate, the IFE
may be a better method to be used. This is because, by observing the difference between
the forward rate and our forecasts, the deviation is less than 0.2% with the IFE while the
deviation becomes considerably larger (around 1%) with the PPP. A further analyses
including testing the accuracy of our forecasts by conducting a back test can be done upon
equest.
Commented [A14]: The title is not so informative
Commented [A15]: Explain what those are with appropriate
literature backup.
Commented [A16]: Enumerating those numbers hardly are
informative.